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Why does the manager impose restrictions on the owner's ability to finance the hotel?

We are currently running a 10-part series discussing particular provisions and concepts within hotel management agreements.

The purpose of this series is to discuss common hotel management agreement provisions and concepts from the perspective of both hotel managers and hotel owners. Hopefully, we will touch upon one or more topics, which spark an "I've always wondered why that is the way it is, but nobody has taken the time to explain it" reaction with you. We trust the discussion goes some way to demystify the topic.

Our 10-part series will cover the following topics:

Why is the manager's fee based on hotel's revenue and profit and not some other basis?

Why do some agreements provide that the manager is the owner's agent and some do not?

Why does the owner employ most or all of the hotel employees (and not the manager)?

What is the risk/reward relationship between an owner and manager?

Why does the owner indemnify the manager?

Why do we need a non-disturbance deed between the owner, manager and financier?

Why do we need an area of protection?

Why is the owner usually prevented from selling the hotel to one of the manager's competitors?

Why does the manager impose restrictions on the owner's ability to finance the hotel?

What is the importance of brand standards?

There are many other lawyers in our firm scattered across the globe that have experience and expertise in negotiating hotel management agreements. These lawyers may have views on all the topics discussed in this series which vary from the views of the authors. Today, we will continue this series with the ninth topic.

For those readers who may not have received all of the prior newsletters in this series, and who would like to read any of such newsletters, then please click on the heading of the relevant newsletter above and a link will take you to the relevant newsletter

Why does the manager impose restrictions on the owner's ability to finance the hotel?

Avid readers of this newsletter will recall that Part 6 was devoted to non-disturbance deeds which bring the manager, the owner and its financier into contractual relations.

In this newsletter, we discuss other relatively common manager requirements with respect to owner financing. That is, why does the manager want to have a say in the owner's financing?

The manager wishes to have the right to review the owner's financing to ensure that the owner's financing is prudent and the owner is not over-leveraged. Otherwise, the owner's financing default could result in the hotel being placed under the financier's control. Managers are keen to avoid this circumstance as it would prefer not to have the financier as its de facto owner and would wish to avoid the potential brand damage and operational interruptions which may arise when a hotel falls under the control of the financier.

Managers typically seek to impose financing restrictions which may include:

specifying the class of lenders from whom the owner can borrow;

excluding any lender which does not pass a "fit and proper" test as prescribed by the manager;

restricting the borrowing solely to the construction and operation of the hotel;

imposing a maximum loan to valuation ratio on the amount borrowed; and

imposing a maximum loan to valuation ratio on the amount borrowed; and hotel gross operating profit.

Owners need to give careful consideration to the ramifications of these requirements, which may result in a contraction of the pool of available financiers and/or an increase in the cost of financing.

Owners should not only consider the ramifications of these requirements for their own purposes, but also the impact on any potential purchaser of the hotel, as reasonably onerous financing requirements may have an adverse impact on the hotel sale price otherwise achievable by the owner.

Typically, the owner and the manager will need to negotiate a set of reasonably balanced contract terms on this issue, which sometimes are embodied in a side letter specific to the current owner.

It is of supreme importance for financing matters to be competently negotiated and drafted, including an agreed form of non-disturbance deed if necessary. Advisors who do not possess appropriate expertise to advise upon and implement these provisions would have difficulty working out a reasonably balanced arrangement between the parties - and such advisors' lack of expertise could cost the owner dearly.

We would be happy to elaborate on this topic and the key negotiation considerations to any interested reader.

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